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401(k) Catch-Up Contribution Change

Employees who have a Section 401(k) plan are allowed to contribute up to $22,500 in 2023. Workers who are age 50 and older can also transfer a "Catch-Up" contribution of $7,500 to their account. The total 2023 contribution could be $30,000 for these individuals.

In 2022, Congress passed a major retirement bill with the title Secure 2.0 Act. This bill changed many of the rules on retirement contributions. One change is scheduled to take effect in 2024. Individuals who have earned over $145,000 will be able to make a 401(k) catch-up contribution of $7,500 (with potential increases in 2024 and future years). However, the catch-up contributions in 2024 and future years must be after-tax funds to a Roth IRA. Previously, the law permitted the catch-up contribution to be added to the regular 401(k) and funded with pre-tax dollars. The changed rule will require higher-income taxpayers to pay taxes now and transfer funds to the Roth IRA. Congress passed the Roth IRA rule for catch-up contributions because individuals will pay more taxes in an earlier year with a Roth IRA.

On June 29, a coalition of over 100 organizations sent a letter to the House Ways and Means Committee leaders. The coalition includes the National Association of State Retirement Administrators and many other organizations. The letter explained there is no possible way that the computer software for these organizations can be updated in time to handle the catch-up Roth IRA change for 2024. The letter notes, "But we have been struck by the overwhelming input from the retirement community that this particular task simply cannot be done in time by a vast number of plans."

The organizations warn that "many retirement plan participants will lose the ability to make catch-up contributions at the end of this year."

The organizations recommend that Congress or the Internal Revenue Service (IRS) allow a two-year delay in requiring a Roth catch-up IRA. They continue, "These circumstances pose a long list of other obstacles, including, for many plans, the challenges of adding a Roth feature and communicating that feature to participants, as well as special challenges for state and local governments and collectively bargained plans."

Editor's Note: The threat that many plans will need to eliminate 2024 catch-up contributions is quite substantial. It is possible that Congress or the IRS will delay the implementation of this new rule.

Inherited IRA RMD Relief For 2023

In Notice 2023-54; 2023-31 IRB 1, the Internal Revenue Service (IRS) waived distributions for many inherited IRAs for 2023.

Under Section 401(a)(9), there is a requirement for most qualified retirement plans to start making a required minimum distribution (RMD) by the applicable beginning date. The Secure 2.0 Act changed the RMD age from 72 to either age 73 or age 75, depending upon the individual's birth date. If an IRA owner was born in 1951, he or she has a required beginning date of April 1, 2025. If the IRA owner is age 73 in 2024, he or she must take their first distribution by April 1 of the following year.

Under Section 401(a)(9)(B)(i), the beneficiary of a deceased IRA owner's account must take a distribution at least as quickly as the employee's distribution schedule if the employee passes away after the RMD date. If the IRA owner dies after distributions have begun, the general rule is that distributions must be within five years or over the life expectancy of the designated beneficiary.

The Secure Act of 2019 changed the rules for most beneficiaries. Except for individuals who have a chronic illness or disability, most children who are beneficiaries will have a required distribution period of 10 years. The distribution over 10 years, rather than life expectancy, increases the potential income tax on traditional retirement plan payouts.

Section 4974(a) states that failure to take the RMD will subject the recipient to an excise tax. In 2023 and subsequent years, the excise tax is 25% of the amount that is below the RMD.

The IRS published proposed regulations on February 24, 2022 (87 FR 10504) and indicated that children or other recipients with a 10-year payout would be required to take annual RMDs if the decedent had reached his or her required beginning date. This requirement to take annual distributions was severely criticized by many plan administrators who thought that the distribution schedule under the 10-year plan should be similar to the 5-year plan. All distributions under the 5-year plan may be taken in the 5th year if desired.

Because there has been criticism of this IRS proposed rule, the IRS waived the 10-year plan distribution requirement for children and other recipients for 2022 and 2023. The distribution requirement remains uncertain until the IRS publishes final regulations.

Editor's Note: While the 10-year plan RMD has been waived for 2023, there is still a judgment call to be made for beneficiaries. Delaying distributions into future years may be compressing large amounts into a year and pushing beneficiaries into a higher tax bracket. In addition, after 2026 it is possible that the tax rates in each bracket may increase. While most beneficiaries subject to the 10-year rule will defer distributions, it is prudent to consider the potential for substantially increasing future taxes.

Fashion Show Charitable Deduction Denied

In Cassandra Tucker et al. v. Commissioner; No. 7896-19; T.C. Memo. 2023-87, the Tax Court determined that a benefit fashion show did not produce a charitable deduction because there was no qualified contemporaneous written acknowledgment.

Taxpayer Cassandra Tucker and her husband filed joint tax returns. Ms. Tucker has a degree in computer science, but created a sole proprietorship named Camarbre. She has operated the Camarbre fashion business since at least 2012. Ms. Tucker planned to sell clothing, handbags, accessories and makeup for women with the hopes to extend the brand for men as well. She operates the business from a room in her home. The business has had challenges in producing sales and has sustained losses for multiple years.

Ms. Tucker attends the International Outreach Ministries (IOM) church. In 2017, she planned to create a fashion show benefit to raise funds for the church. The show was held on November 26, 2017. Ms. Tucker paid expenses for models, hairstylists, makeup artists and food. IOM charged the public to attend the fashion show and kept all proceeds.

IOM Pastor Isaac Adeyemi sent her a letter and thanked her for a donation of $25,000. However, the letter did not contain a statement that said, "no goods or services were provided in exchange for the donation."

Ms. Tucker also received two unsigned documents from IOM that indicated payments for various fashion show items. The claimed total payments for the show were $14,050. In addition, the couple made cash gifts to IOM of $11,500. They reported a $25,000 charitable deduction on their 2017 Schedule A.

Charitable deductions to a qualified exempt organization are deductible under Section 170(a). However, a deduction of $250 or more requires a contemporaneous written acknowledgment (CWA). See Section 170(f)(8)(A). While expenses that are related to services for a charitable organization may be deductible, they are also subject to substantiation requirements. Reg. 1.170A-13(f)(10). The expense is not deductible unless the taxpayer records the name, date and amount of the contribution or has "other reliable written records." Reg. 1.170A-13(a).

The taxpayers claimed a deduction of $25,000. While the IRS initially issued a notice of deficiency and disallowed the entire deduction, the Service later conceded that the cash gifts of $13,050 were permitted, but the fashion show charitable deduction of $14,050 would be denied.

The Tax Court noted that the claimed receipts for the fashion show deduction were "woefully inadequate for purposes of satisfying the section 170(f)(8)(B) CWA requirements." Because the receipt was inadequate, the fashion show charitable deduction was denied.

Editor's Note: If the taxpayer had records of the fashion show items with amounts and dates, the nonprofit could have provided a CWA listing these specific items (but not including the amounts). The receipt could also have included the required language that "no goods or services were provided in exchange for the donation." With a CWA and detailed records, the taxpayer could have qualified for a charitable deduction.

Applicable Federal Rate of 5.0% for August -- Rev. Rul. 2023-13; 2023-32 IRB 1 (17 July 2023)

The IRS has announced the Applicable Federal Rate (AFR) for August of 2023. The AFR under Sec. 7520 for the month of August is 5.0%. The rates for July of 4.6% or June of 4.2% also may be used. The highest AFR is beneficial for charitable deductions of remainder interests. The lowest AFR is best for lead trusts and life estate reserved agreements. With a gift annuity, if the annuitant desires greater tax-free payments the lowest AFR is preferable. During 2023, pooled income funds in existence less than three tax years must use a 2.2% deemed rate of return. Charitable gift receipts should state, "No goods or services were provided in exchange for this gift and the nonprofit has exclusive legal control over the gift property."

Published July 21, 2023
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